About the author

Mark J. Perry is concurrently a scholar at AEI and a professor of economics and finance at the University of Michigan's Flint campus. He is best known as the creator and editor of the popular economics blog Carpe Diem. At AEI, Perry writes about economic and financial issues for American.com and the AEIdeas blog.

A new Amazon pricing puzzle: Why does a bundled album (CD + MP3) sell at a deep discount to the MP3-only version?

Last fall, I had a post about a “pricing puzzle” in regards to the way Amazon prices its CDs and MP3 music. I asked the question, “Why do the MP3 versions of an album sometimes sell for a 50% discount and sometimes sell for a 50% premium compared to the CD version of the same album?” Some of the commenters provided some plausible explanations to that pricing puzzle:

Dan Hill: A lot of it has to do with the intellectual property rights. Different people can own the rights to different formats and have different views about pricing. Plus, pricing on physical products like CDs can be affected by inventory issues (clearance sales due to overstocking).

Tom Davis: I would guess that the copyright holders set the price for digital media, but Amazon purchases CDs from the distributor and gets to decide the price (including whether they will take a loss to free up warehouse space). Consequently, I doubt digital download music or videos fluctuate in price the same way physical media does.

Well, here’s a new pricing puzzle. In the previous example, consumers were given the choice between: a) buying a physical CD, or b) buying the MP3 version of the same album, and the MP3 version was priced at a premium in some cases, and at a discount for other albums. Today, when I went to buy the Etta James album “Time After Time” on Amazon I was given the following two choices: a) buy the MP3 version for $9.99, or b) buy the CD version for $3.99, which included a free MP3 download version of the album (see graphic above, click to enlarge)! In other words, you pay a premium of $6 to buy the MP3 version only without the added benefit of also getting the CD version. Or you get a $6 discount to get the bundled package (CD + MP3 version) compared to buying the MP3 version only. For another Etta James album, Mystery Lady, the pricing was similar, although the bundled package (CD + MP3) was $7.79 compared to $9.99 for only the MP3 version, so the discount for the bundled package was lower than for the other album (see graphic above).

How does Amazon’s pricing strategy make sense? It allows a consumer to spend less and get more with the bundled purchase, and spend more and get less with the MP3-only option. I can understand the inventory/overstocking explanation, which would lead to a discount for the CD, but then why give away the MP3 version for free? And the “different copyright holders” explanation wouldn’t seem to apply here. So the new pricing puzzle is why would a bundled package (CD + MP3) sell at such a deep discount (60% in the case above) to the MP3 version only?

Discussion: (29 comments)

It seems to me that this is pretty clear-cut price discrimination. People searching specifically for CDs may be used to shopping around under the notion that there are a thousand places to buy CDs, while MP3 downloaders may be more used to locked in environments like the iTunes store.

Also, there may be a demographic component to this discrimination. CD purchasers may be older, poorer, less tech savvy, and less likely to have an MP3 player, and thus the expected cost of the MP3 giveaway is some fraction of the actual cost of the MP3 giveaway related to the likelihood of these old folks actually taking amazon up on the offer. In contrast, the younger, tech savvy MP3 audience is likely to be wealthier just by virtue of having been able to afford an MP3 player, and may thus be less price sensitive.

The $3.99 comes with orders over $25. When I just select the album it is $7.97 shipped to me. Still seems like this is just paying someone who only cares about the mp3s to clear out inventory for them.

How is this different than the way the Economist prices its services when the online only and online and print edition cost the same amount per year? One sees this also in the classical music part of Amazon. Note that if you look at some albums you find also the ability to download per track for some of the tracks as well. (Which even for the number of tracks allowed costs more, in that case basically a quantity discount). It should be noted that the rip service also is only available for some albums again depending on agreements with the publishers. Also Amazon, and also Arkive music make custom cd to order, a vision of the future where the inventory is basically a big server.

Don’t over-intellectualize this. Pricing is done to maximize profits. Evidently all concerned believe that these ‘illogical’ prices vs other prices make them more money. Evidently the buying public isn’t smart enough to make these distinctions. Caveat Emptor.

Here’s one idea: They want to get the people who normally only buy CDs to switch over to MP3s so they can eliminate CDs in the future. They need to provide both the CD so they will buy it and the MP3 so they may try it. There’s no upside to currently discount the MP3 only purchase.

Perhaps the incentive is for the CD consumer to get into new technology. By offering an incentive (the CD as a loss leader) to the CD consumer to get both formats (CD and MP3), it would prod them to purchase Amazon’s Kindle. Thereby, setting up the consumer (of CD’s) as a new entrant to the digital market. Then in the future that consumer would buy e-books for their Kindle.

Mark, that is part of Amazon’s Autorip program to promote its cloudplayer music service to compete with iTunes and others. If you have ever purchased a CD from Amazon then the mp3s will be automatically available in your cloudplayer account.

Amazon wants a fast uptake of its Cloud Player service and autorip is one way to lock-in customers.

Note to be clear that applies only to CDs that Amazon has negotiated the rights to do the for. For example I bought some Canadian Brass CDs recently and they did not come with this. To see which look for the autorip symbol. Basically autorip saves you the 5 mins per disc it takes to rip a cd to your computer.

The “free mp3″ version is simply a burned copy of the CD you just purchased. Amazon doesn’t have to pay a royalty on that like they do a mp3 version that isn’t burned from an orginial CD.

Amazon probably bought those CD’s for pennies on the dollar and would love to have you take them off their hands. Their profit margin on the physical CD’s is huge compared to MP3 profits. The burn of that CD they put in your hard drive isn’t a licensed MP3 they have to pay royalties on.

None of the price discrimination and loss leader explanations make any sense. Price discrimination requires discrimination. In this case, one option is superior for all consumers. A loss leader designed to encourage the use of other Amazon products would mean the MP3 version should be cheaper.

No, it’s almost certainly contracts. The MP3s included in the CD+MP3 package is probably fair-use that avoids the digital royalties. Or at least that would be Amazon’s claim.

“No, it’s almost certainly contracts. The MP3s included in the CD+MP3 package is probably fair-use that avoids the digital royalties. Or at least that would be Amazon’s claim.”

A “fair use” claim is a positive defense against an accusation of copyright infringement. It’s not likely that Amazon could claim that it has made digital copies of each CD sold and then distributed those digital copies to customers along with the CDs.

Fair use might be a defense a person could use if charged with copyright infringement for copying a CD of DVD they had purchased – which is a license to use the material – for their own use, to prevent loss due to damage to the physical medium.

I can make a physical copy or rip electronic copies for everyday use, while keeping my originals safely stored away.

I can’t seem to find the article again. I believe it was CBS News. Anyway, Amazon is relying on Capitol Records v. MP3Tunes (2011) which not only allows users to store their CDs online but also allows “deduplication” enabling music locker services to host a single copy. So Amazon can make its own copy available to anyone who has the CDs.

Reminds me of the K-Mart snafu with the Manatee Grey dress for plus size women cheaper than the Dark Heather Grey for petite. More cloth in the big dress…but I guess with the US “expanding” there is a volume discount on the big dresses.

I’m an FBA seller on Amazon with some 10,000 titles listed and I supply Amazon directly on some older titles.

For the lowest possible, churn inventory to get rid of it price of 3.00 on a FBA CD, Amazon’s cut is 2.82 on the lowest price FBA CD. The non FBA seller can go to a penny and 3.00 for S&H. Amazon risks nothing and gets paid rent. If the item, beyond the first copy sits on their shelves for too long, Amazon charges a 40 cent or higher fee per item biannually. Amazon is pushing this risk free product hosting. I’m pretty sure that Amazon wants cheap prices to get many high profit FBA sales. Too many small FBA sellers race to low prices in a foolish attempt for sales. The mega liquidation sellers, million + items a year, can make a profit on cents per CD on the long tail end of the supply curve (personal phrasing) portion of inventory. At 3.00 a CD, even I recoup my cost of the CD on 80% + of my inventory.

When they sell their CD+MP3 package, Amazon attracts the must-own-a-physical-copy-crowd, there’s still many of out there, and they also get a chance to get us to try the high margin downloads on full albums and not just single songs. They’re trying this out with minor artists because they can negotiate a better deal than with the record company cartel who love the high priced, low margin CDs.

The minor artist supplies Amazon directly and these low volume artist send their CDs on consignment at Amazon’s whim. Amazon’s cut is almost half the price. Amazon risk only a few inches of warehouse space and a few elections on hard drives. Amazon deals with the cartel on a palette per title basis with upfront costs. A CD palette is about 7,000 CDs; I have some 150 CD and DVD palettes. As with books, these cartel titles are loose money on 8-10 and make a profit on 1. Amazon has a potential pool of hundreds of thousands (Millions?) of small time artists.

Amazon risk only pennies per title and gets an upside of 3+ dollars. They also expand their digital, demand to us who buy whole albums. They only pay digital royalties, 10-20% of the price, and get 80-90% when they make the sale. Why wouldn’t they sell like this?

Amazon makes money on these titles, no matter how popular the title is.

it’s easy to see why CD’s and pm3’s might vary in their price relationships.

it’s an inventory issue. if you have a lot of discs and need to move them, you drop the price and free up cash. there is no cost to holding mp3 inventory.

this would create some situations where you wanted to move CD’s at any price.

why one would sell a cd and an mp3 for less than the mp3 is a little trickier, but i can imagine some possible reasons.

1. are we sure it is the same quality mp3? if one is 128 and the other 320, that might make a difference.

2. but i think the real issue is one of drm. if you buy a cd, you can rip it to mp3 with extreme ease. but that mp3 will not be the same as the one you get from amazon or particularly apple. it will not have DRM that makes it hard to share online and limits device count.

perhaps this is an attempt by the copyright holders to spread DRM limited mp3’s as opposed to encouraging people to rip their own?

if you were sony music, might it be worth giving away the mp3 in a controlled form if it stopped people from creating their own open versions?

Lots of interesting takes. I’ll add that I have a friend who, when he buys a physical CD, doesn’t even bother to rip it. He just downloads it from bittorrent or similar in an instant. For all I know, the CD sits on the shelf unopened.

Just for completeness I went to a cd mastering and reproduction shop, and their quotes range from .92/cd in a jewel case @1000 to .55/cd at 25000. One can be sure that record companies pay less. So the variable cost of a cd, is less that $1.00. So if you add the shipping to the warehouse you might get up to $1.25. Of course the interesting question is what does Amazon IT charge for the server and disk space for a cd (internal charges never published), but typically these are a per month charge, I suspect a charge for disk space and a charge for the download.

I would just like to comment that the explanations postulated here that involve warehousing costs make no sense. Amazon is not doing this to particular CD’s they are trying to unload, it covers almost all CD’s they sell, and is unrelated to how recently the CD was released. This actually increases the their need to warehouse, as they are encouraging the sale of CD’s + MP3’s vs MP3’s alone.